Argentina's crisis is not the only challenge facing Mercosur's relations with the European Union. But the crisis could also give those relations an impetus.
BY STEVE HANKE AND KURT SCHULER
RECENTLY, BOTH Ecuador and Argentina announced their statistics of tax collection for the first two months of this year. Ecuador reported that its nonoil tax collections for January and February were 41 percent higher than for January-February 2001. This follows on the heels of a 42 percent increase in 2001 over 2000. (Ecuador also receives considerable tax revenue from oil exports, but the amount of revenue fluctuates considerably based on the world price of oil, so it is not a good gauge of the condition of the overall economy. Part of the increase in nonoil tax revenue reflects prices catching up to world levels after falling far behind in 1999. The increase remains impressive even so.)
Ecuador dollarized in 2000 after a currency crisis and depression in 1999. Since dollarizing, Ecuador has not increased any major tax rates. It eliminated a widely despised financial transaction tax of 0.8 percent that generated about 20 percent of all nonoil tax revenue in 2000. The International Monetary Fund wanted Ecuador to raise its value-added tax from 12 percent to 14 percent, and the government agreed (against its better judgment) so as to receive a loan from the IMF. Ecuador's constitutional court rejected the increase as unconstitutional, however, so the value-added tax has remained at 12 percent.
Argentina has had declining tax revenues over the last several years. Collections for January and February were 20 percent lower than in January-February 2001. What is more, that figure is not adjusted for the massive exchange-rate depreciation that Argentina has suffered. The Argentine peso, linked at 1 peso per dollar from April 1991 to January 2002 under Argentina's "convertibility" monetary system, was unlinked in early January. It depreciated to more than 2 per dollar at the end of February and to 4 per dollar today.
Argentina imposed big tax increases in January 2000, April 2001, and August 2001 under then-president Fernando de la Rúa. The government of president Eduardo Duhalde, in power since the beginning of 2002, has proposed a variety of new taxes to reduce the budget deficit. In addition, the depreciation of the peso, and the inflation that is now starting to be felt, are increasing effective (inflation-adjusted) tax rates. The top income tax rate of 35 percent begins at 102,300 pesos per year. At one peso per dollar, the equivalent is $102,300. At four pesos per dollar, the equivalent is $25,575.
What is the solution? Argentina should imitate Ecuador and dollarize. At the same time, it should make drastic reductions in its tax rates, which are much higher than those of Ecuador and provide huge incentives to evade taxes. Argentines are well practiced at avoiding high tax rates, so under current policies the government can expect tax revenue, in particular revenue from income taxes, to fall sharply.
We propose the following particular reductions of tax rates:
- Eliminate the financial transaction tax.
- Reduce the value-added tax immediately from 21 percent to 15 percent, with a longer-term goal of 10 percent.
- Unify the payroll tax and income tax into a flat-rate tax of 25 percent, with a longer-term goal of 20 percent.
The International Monetary Fund is waiting for Argentina to present a plan that includes a "disciplined" budget before lending money for currency stabilization. Rather than currency stabilization being the result of a disciplined budget, Argentina has little change of achieving a disciplined budget unless it first stabilizes its monetary situation through dollarization.
Real GDP growth (%)
Tax revenue (bn pesos)
Year over year change (%)
Real GDP growth (%)
Nonoil tax revenue (bn US$)
Year over year change (%)
Sources: Argentina, Ministry of Economy, Secretariat of Finance, Undersecretariat of Financing, "Main Macroeconomic Indicators," http://www.mecon.gov.ar/download/financiamiento/newinf.xls; Ecuador, Servicio de Rentas Internas, http://www.sri.gov.ec/pdf/estadisticas2001web.pdf, p. 5; IMF World Economic Outlook, December 2001; news reports.
Kurt Schuler is a Senior Economist at the Joint Economic Committee of the U.S. Congress. These are his personal views, not necessarily those of the committee. Steve H. Hanke is Professor of Applied Economics at The Johns Hopkins University in Baltimore, President of Toronto Trust Argentina, and a Senior Fellow of the Cato Institute.
Originally published April 1, 2002